A.P. Microeconomics In Class Review #2
Pricing 1. Pricing system serves as a rationing device The market decides who gets g&s by which households are willing to pay the price for it!!
Pricing a. Even when price ceilings are implemented to keep prices at a fair level, the rationing system will usually win out. The Market will find a way to get to its happy place, even if it s illegal!! Ex) black markets, scalping, ebay, etc.
Pricing Consumer Surplus The difference btwn utility gained and price paid (what we are willing to pay over actual price) Price Producer Surplus The difference btwn what producers are willing to sell at and actual price S P X Consumer Surplus Producer Surplus D Quantity
Elasticity How sensitive are firms and households to changes in price (Laws of Supply and Demand) To what degree will quantity change? Formula %ΔQD %ΔP
Term Def Formula Examples Graph Elastic Inelastic %ΔQD > % ΔP Big change in quantity dem %ΔQD < %ΔP Little change in quantity dem E D > 1 0 < E D < 1 Not urgent, Large portion of budget, Lots of substitutes Urgent, no substitutes, small portion of budget, medical needs Low slope, Higher priced parts of line Steep slope, lower priced parts of line Unit Elastic %ΔQD = %ΔP Same change in quantity dem E D = 1 Proportional change 45 angle
Term Def Formula Examples Graph Perfectly Elastic %ΔP = 0 E D = Perfect Subs, fruits & veggies Horizontal Line Perfectly Inelastic %ΔQD = 0 E D = 0 No Subs, unique limited product Vertical Line
Factors Affecting Elasticity 1. Substitutability 2. Luxury vs. Necessity 3. Addictiveness 4. Time 5. Budget P X vs. portion of budget
Practice Problems: 1. Price of strawberries increase from $3 to $4 per pint and sales of strawberries decrease by 50%, how elastic are demand for strawberries? Q 1 Q 2 Q 1 P 1 P 2 P 1 E (3 4)/3 D = = (3 4)/3.33 = =.50.50.50 E D = Inelastic OR - %ΔQD is +33%, %ΔP = 50% Since quantity changed less than price it is inelastic.66
Practice Problem 1. Price of iphones decrease by 25% and sales increase by 33%, how elastic is the demand for iphones?.33/.25 = 1.32 = Elastic OR, %ΔQD is +33%, %ΔP = 25% Since quantity changed greater than price it is elastic
Demand Graph & Elasticity Find Midpoint of the line!!! Price E D > 1 at high prices, Elastic E D = 1 at midpoint, Unit Elastic 0 < E D < 1 at low prices, Inelastic Demand Quantity
Revenue Test Total Revenue = p q Price Quantity Total Revenue $1 10 2 8 3 6 4 4 5 2 6 0 $10 $16 $18 $16 $10 $0
Revenue Test Price increase from $1 to $2, type of elasticity and what happens to TR? E D = Inelastic and TR Increased Price change from $3 to $4, type of elasticity and what happens to TR? E D = Unit Elastic and TR Decreased Price change from $4 to $5, type of elasticity and what happens to TR? E D = Elastic and TR Decreased How can a firm increase Revenue? If Elastic Decrease Price If Inelastic Raise Price!!!
Price D Quantity Revenue Elastic Inelastic Unit Elastic Total Revenue Output
Cross-Elasticity of Demand Measuring the change in quantity of one good when the price of a related good is changed. %ΔQD Y %ΔP X RULES: positive sign goods are subs negative sign goods are comps
Income Elasticity of Demand Compares change in income to change in quantity demanded Normal good = buy more with more $ Inferior good = buy more with less $ %ΔQD %ΔI RULES: positive sign = goods are normal negative sign = goods are inferior
Utility, etc. Utility: satisfaction from consumption Marginal Utility: satisfaction from consumption of additional units Diminishing Marginal Utility: decreasing satisfaction from consumption of additional units
Utility-Maximizing Rule Ranking choices when consuming many goods; where will households get most utility per dollar: MU A MU B MU C = P A P B P C =
Answer: 4 cds and 5 candies Budget Constraint: $52 Price of CDs: $8 Price of Candy: $4 Units of CDs Utility Marginal Utility MU MU/P Units of Candy Utility 1 56 56 1 32 2 104 48 2 60 3 136 32 3 84 4 160 24 4 104 5 180 20 5 116 6 196 16 6 126 7 208 12 7 134 7 6 4 3 2.5 2 1.5 Marginal Utility MU 32 28 24 20 12 10 8 MU/P 8 7 6 5 3 2.5 2
Income Effect As the price of a particular good decreases, a consumer can afford more of it and other goods Ex) a usually expense (rent) gets cheaper so you have more money to spend!!
Substitution Effect As the price of a particular good decreases, a consumer may buy more of this good relative to the price of a substitute good Ex) moving to a cheaper apartment